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Dec 6, 2018

Production stories offer leverage in rising gold markets

Jason Smith, special to BNN Bloomberg from Market One Media

3.8 km of underground development is complete at the Fruta del Norte project in southeast Ecuador.
, Image courtesy of Market One Media

With five million ounces of high-grade gold reserves, Lundin Gold’s Fruta del Norte project is on track for production in 2019

A successful transition to production could generate a re-rating of the company’s share price

In a bull market, the first companies that investors will seek out will be production stories

With gold prices currently trading in a range above the US$1,200 mark, bulls for the yellow metal are looking for ways to place bets on a price breakout to the upside.

The current economy in the U.S. is keeping the dollar strong, which is subsequently keeping a lid on higher gold prices. In the longer term, though, there’s the possibility that wage increases could spark inflation fears, which would be a bullish trend for gold.

If history is any guide, should a gold bull market emerge, the first companies that investors will seek out will be production stories. The reason is simple: companies with producing gold mines have the ability to convert those higher gold prices into cash flow, while exploration and development-stage companies are more bets on the promise of higher gold prices in the future.

Pretium Resources’ share price movement in the first half of 2016 is a good example of the production story phenomenon. With the company moving ahead with construction on its high-grade Brucejack mine and gold trending higher, the company’s share price went from US$4.28 to US$11.28 in just six months. Investors were betting that those higher prices would soon translate into profits and cash flow once Brucejack came online.

“Once you’re in production and meeting targets, you typically see a valuation re-rating. Investors need that comfort level of actual production versus saying you’re going to produce.”

The project is on pace to become a significant new underground gold mine, with 5.02 million ounces of probable reserves grading an impressive 8.74 grams per tonne. At those grades, FDN will have one of the lower cost profiles in the gold sector, with all-in sustaining costs of approximately US$583 per ounce.

At those per-ounce costs, it’s easy to see how FDN will help Lundin Gold convert current prices into cash flow, especially if gold prices continue to rise from here. According to Lundin Gold’s President and CEO Ron Hochstein, “Once you’re in production and meeting targets, you typically see a valuation re-rating. Investors need that comfort level of actual production versus saying you’re going to produce.”

Fruta del Norte is Well on its Way to Production

By all accounts, construction is on-time, and on budget for the first gold pour in the fourth quarter of 2019. The mine at FDN will have a 15-year life span and will produce 4.6 million ounces of gold.

Construction is currently around one-third complete, and a significant portion of the project’s capital expenditures have been committed and incurred. Underground development is set to reach the orebody continue apace, with 3.8 kilometres of underground development currently complete.

Thanks to the backing of major investors like Orion Mine Finance, Blackstone Tactical Opportunities, Newcrest Mining, and the Lundin Family Trusts, Lundin Gold has the financing it needs to get FDN into production. As for permitting, Hochstein says that the company has “the three major ones we need in place.”

Moreover, the company has enjoyed a friendly relationship with Ecuador, which has become more mining focused in recent years. The oil revenue-dependent country has a US dollar denominated currency and has had to diversify its economy as oil prices have slumped in the past few years.

Process plant construction is well underway at Fruta del Norte.

Growth Through Drilling is Possible

Although FDN is already a large deposit, the company sees possibilities to add to its overall resources and reserves through drilling.

The first target would be a sparsely drilled southern portion of the FDN resource that Lundin Gold will be able to access when it reaches the deposit underground. Hochstein comments, “The probability of increasing the reserves is significant once we get underground. The south end of the deposit was not drilled out very well. We’re excited about getting to that south end and drilling that out.”

The project also sits on the northern end of a high-potential trend in the region. The company hopes to do some exploration drilling on areas to the south, as soon as next year.

In the interim, Lundin Gold’s focus will be on keeping construction on track at FDN. Right now, it’s using Pretium’s enterprise value per reserve ounce as a target for its valuation once production begins on the project.

Such are the spoils that typically accrue to companies that make the leap from production stories to producing mines.